Menard, Inc. v. Comm'r of Internal Revenue

Decision Date19 February 2008
Docket NumberNos. 673–02,674–02.,s. 673–02
PartiesMENARD, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentJohn R. Menard, Petitioner v. Commissioner of the Internal Revenue, Respondent.*
CourtU.S. Tax Court
OPINION TEXT STARTS HERE

MI is an accrual basis taxpayer with a fiscal year ending Jan. 31. S is a cash basis taxpayer who was the president, CEO, and 89–percent shareholder of MI during MI's TYE 1998.

In an earlier opinion, the Court concluded that a portion of the compensation that MI paid to S during TYE 1998 was unreasonable and represented a disguised dividend, and consequently MI was liable for an income tax deficiency to the extent S's compensation was not deductible as an ordinary and necessary business expense.

The Court also concluded that S was liable for an income tax deficiency to the extent MI's payment of certain expenses was unreasonable in amount and constituted a constructive dividend to S and S constructively received interest income on loans he made to

MI.

R filed computations for entry of decision pursuant to Rule 155, Tax Court Rules of Practice and Procedure. S and MI objected to R's computations because they did not reflect an offset against their income tax deficiencies equal to the amount of hospital taxes that S and MI overpaid under secs. 3101(b) and 3111(b), I.R.C., in respect of the portion of S's compensation that the Court recharacterized as a disguised dividend.

After the submission of the computations and related objections, Congress passed the Pension Protection Act of 2006(PPA), Pub.L. 109–280, sec. 858, 120 Stat. 1020, which amended sec. 6214(b), I.R.C ., to provide that the Tax Court may apply the doctrine of equitable recoupment, effective for any action or proceeding in the Court with respect to which a decision has not become final as of Aug. 17, 2006. Sec. 6214(b), I.R.C., as amended by PPA sec. 858, provides that the Court has jurisdiction to apply the doctrine of equitable recoupment to the same extent that the doctrine is available in civil tax cases before the District Courts of the United States and the U.S. Court of Federal Claims.

Held: Where, as here, the Court has original jurisdiction to redetermine a deficiency pursuant to sec. 6213(a), I.R.C., the Court may apply the equitable recoupment doctrine even if the Court lacks subject matter jurisdiction over the type of tax to which the equitable recoupment claim is directed.

Held, further: The requirements for establishing a claim of equitable recoupment are satisfied in this case, and S and MI are entitled to an offset against their income tax deficiencies equal to the hospital taxes that S and MI paid on the portion of S's compensation that the Court recharacterized as a disguised dividend.

Held, further: Before MI's income tax deficiency may be offset by the hospital tax in question, MI must eliminate or back out the deduction for such hospital tax that it claimed on its tax return for 1998.

Robert E. Dallman, Vincent J. Beres, and Robert J. Misey, Jr., for petitioners.

Christa A. Gruber, J. Paul Knap, and Michael Calabrese, for respondent.

SUPPLEMENTAL OPINION

MARVEL, Judge:

This matter is before the Court on petitioners' objection to respondent's proposed Rule 155 1 computations submitted in response to our holdings in Menard, Inc. v. Commissioner, T.C. Memo.2004–207 (Menard I), and Menard, Inc. v. Commissioner, T.C. Memo.2005–3 (Menard II). As discussed in greater detail below, in Menard I we held that petitioners are liable for income tax deficiencies for the taxable year ended (TYE) 1998. In Menard II we denied petitioners' motion for reconsideration.

The issue we must decide is whether, under the equitable recoupment doctrine, petitioners are entitled to an offset against their income tax liabilities for TYE 1998 equal to the amount of so-called hospital insurance taxes that they overpaid pursuant to sections 3101(b) and 3111(b) on the portion of petitioner John R. Menard's compensation recharacterized in Menard I as a disguised dividend.

Background

We adopt the findings of fact set forth in Menard I. For convenience and clarity, we repeat below the facts necessary for the disposition of this matter, and we supplement those findings with additional facts as appropriate.

Menard, Inc. (Menards), was incorporated in Wisconsin in 1962 and is engaged primarily in the retail sale of hardware, building supplies, paint, garden equipment, and similar items. As of the trial date, Menards had approximately 160 stores in nine Midwestern States and was one of the nation's top retail home improvement chains.

John R. Menard (Mr. Menard) served as president and chief executive officer of Menards and has been a controlling shareholder of Menards since its incorporation. During the period in question, Mr. Menard owned approximately 89 percent of Menards's voting and nonvoting stock.

Menards is an accrual basis taxpayer and has a fiscal year ending January 31 for tax and financial reporting purposes. On October 15, 1998, Menards timely filed Form 1120, U.S. Corporation Income Tax Return, for TYE 1998. On October 12, 2001, respondent sent to Menards a notice of deficiency with respect to its TYE 1998. Menards timely petitioned this Court seeking a redetermination of the deficiency.

Mr. Menard is a cash basis taxpayer with a taxable year ending December 31. Between March 30 and April 15, 1999, Mr. Menard timely filed Form 1040, U.S. Individual Income Tax Return, for 1998. On October 12, 2001, respondent sent a separate notice of deficiency to Mr. Menard with respect to 1998. Mr. Menard timely petitioned this Court seeking a redetermination of the deficiency.

The two cases were consolidated for trial, briefing, and opinion. Following a trial and the submission of posttrial briefs, we issued our opinion in Menard I holding, among other things, that Menards was not entitled to a business expense deduction for a significant portion of the compensation it paid to Mr. Menard for 1998 because the compensation was unreasonable, was not paid entirely for personal services, and was properly characterized as a disguised dividend to Mr. Menard. Separately, we sustained respondent's determination that Mr. Menard was liable for an income tax deficiency to the extent that Menards's payment of certain expenses on Mr. Menard's behalf was unreasonable and constituted a constructive dividend to Mr. Menard.

After we issued our opinions in Menard I and Menard II, we received and filed respondent's computation for entry of decision pursuant to Rule 155 in each of these consolidated cases. Respondent concluded that (1) Menards owed an income tax deficiency of $5,720,334 and a penalty of $188,295.60, and (2) Mr. Menard owed an income tax deficiency of $921,491 and a penalty of $184,298.20. Petitioners filed a notice of objection to respondent's Rule 155 computations in which they alleged that Menards's correct income tax deficiency and penalty amounts were $5,523,488.20 and $188,295.60, respectively, and that Mr. Menard's correct income tax deficiency and penalty amounts were $724,645 and $184,298.20, respectively.2

The parties' deficiency computations for both Menards and Mr. Menard differ by $196,845.81, which is the amount of hospital insurance tax (hospital tax) that Mr. Menard and Menards contend they overpaid pursuant to sections 3101(b) and 3111(b), respectively .3 Petitioners contend that, consistent with our holding in Menard I recharacterizing a portion of the compensation that Menards paid to Mr. Menard as a constructive dividend, they overpaid so much of the hospital tax that they remitted to the Commissioner during 1998 as was attributable to the constructive dividend. Petitioners argue that, under the doctrine of equitable recoupment, they are entitled to offset the amount of their hospital tax overpayments against their respective income tax deficiencies for TYE 1998 and that they have met all of the requirements necessary to establish their equitable recoupment defense.4

Respondent maintains that the Court lacks the authority under the equitable recoupment doctrine to offset petitioners' income tax deficiencies by the amounts of their overpaid hospital taxes because we lack jurisdiction over hospital tax deficiencies and overpayments. Respondent contends that hospital taxes play no role in the determination of a deficiency within the meaning of section 6211 and that neither additional hospital tax liabilities nor hospital tax overpayments are included in a computation for entry of decision because we lack jurisdiction over hospital taxes. According to respondent, applying equitable recoupment in this case “would allow petitioners to slip through a back door to challenge a tax they could not directly petition the Court to review.”

Respondent does not dispute the amount by which petitioners contend they overpaid their hospital taxes, nor does respondent dispute that the elements necessary for an equitable recoupment claim are present in this case.5

Neither Menards nor Mr. Menard filed a claim for a refund of the hospital taxes that they overpaid. The period of limitations for filing a refund claim has now expired with respect to both petitioners.

We have not yet entered decisions in these cases, and consequently no decision has become final within the meaning of section 7481.

Discussion

These cases present an issue of first impression regarding the scope of our authority to apply the doctrine of equitable recoupment. Specifically, we must decide whether the tax that is the subject of a litigant's equitable recoupment defense must be one over which we have deficiency and overpayment jurisdiction under sections 6211 and 6212.

I. Jurisdiction of the Tax CourtA. Deficiency and Overpayment Jurisdiction

Like other Federal courts, the Tax Court is a court of limited jurisdiction, and it may exercise its jurisdiction only to the extent authorized by Congress. Naftel v. Commissioner, 85 T.C. 527, 529, 1985 WL...

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